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Von Thunen AP HUG March 2015 http://today.msnbc.msn.co m/id/46602078/ns/today- today_people/t/doomsday- vault-holds-seeds-could- save-world/#slice-1 http://news.nationalgeogr aphic.com/news/2008/02 /photogalleries/seedvault -pictures/index.html

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Challenges for commercial farmers Challenges for commercial farmers Access to markets is importantAccess to markets is important The von Thünen model (1826) The von Thünen model (1826) The choice of crop to grow is related to the proximity to the marketThe choice of crop to grow is related to the proximity to the market

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Challenges for commercial farmers Challenges for commercial farmers OverproductionOverproduction Agricultural efficiencies have resulted in overproduction Agricultural efficiencies have resulted in overproduction Demand has remained relatively constant Demand has remained relatively constant As a consequence, incomes for farmers are lowAs a consequence, incomes for farmers are low

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Sustainable agriculture Sensitive land management Ridge Tillage (lowering production $$, greater soil conservation) Limited use of chemicals (application of limited if any herbicides to control weeds, no Roundup-Ready) Integrated crop and livestock

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Overview of von Thunen

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Locational Rent The term rent has several meanings… The term rent has several meanings… You may think of it as contract rent or money paid for land or other property.You may think of it as contract rent or money paid for land or other property.

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To understand von Thunen’s model think of locational rent as MONEY MADE! To understand von Thunen’s model think of locational rent as MONEY MADE!

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There is just one problem… There is just one problem… In the real world things don’t always happen as they are predicted in models!

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1. There is a single market place with no connections; his theory was called the isolated state. Is this a likely real life situation? 1. There is a single market place with no connections; his theory was called the isolated state. Is this a likely real life situation? 2. Isotropic surface 2. Isotropic surface 3. Uniform labor costs 3. Uniform labor costs 4. Transportation equally possible in all directions 4. Transportation equally possible in all directions 5. Transportation costs are directly related to distance 5. Transportation costs are directly related to distance 6. Farmers are rational and opt for those types of agriculture that produce the greatest locational rent 6. Farmers are rational and opt for those types of agriculture that produce the greatest locational rent

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1. Production costs remain constant. 1. Production costs remain constant. 2.Transportation costs increase 2.Transportation costs increase 3. Locational rent decreases. 3. Locational rent decreases. Transportation costs and Locational rent are inversely related - one goes up as the other goes down. It's because the transport costs eat into the locational rent.

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Graphically, the greater the distance between the farm and the central market/city, the lower the rent Graphically, the greater the distance between the farm and the central market/city, the lower the rent Note that this theory of differential rent does not assume that land varies by quality Note that this theory of differential rent does not assume that land varies by quality Distance, d Rent

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Thünen also showed that if transportation cost t decreases, fields that are farther off would be brought into cultivation: another testable hypothesis Thünen also showed that if transportation cost t decreases, fields that are farther off would be brought into cultivation: another testable hypothesis Distance, d Rent

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One good case [P – (t × d)] × MPL = w [P – (t × d)] × MPL = w L MPL [P-(t × d f )] × MPL [P-(t × d n )] × MPL A B C w Quantity of Wheat LnLn LfLf There are two farms: near (n) and far (f). The near farm hires more workers and earns more in rent. The near farm earns ABC in rent, whereas the far farm earns only BC.

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Multiple goods case What if there are three goods: wheat, corn, and rice? What if there are three goods: wheat, corn, and rice? The three crops will be cultivated in concentric circles around the central market/city—another testable hypothesis. The three crops will be cultivated in concentric circles around the central market/city—another testable hypothesis. This was the birth of location economics or geographical economics This was the birth of location economics or geographical economics Distance, d Rent Wheat Corn Rice Wheat Corn Rice

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Capital Theory What is the right time to chop down a tree? What is the right time to chop down a tree? Maximization of land rent income implies that the landowner should follow this rule: Maximization of land rent income implies that the landowner should follow this rule: Chop down the tree when the highest possible Present Value obtainable from the tree = Salvage Price of Tree.Chop down the tree when the highest possible Present Value obtainable from the tree = Salvage Price of Tree. Thünen was analyzing actual problems of forestry when he derived this idea. This an example of the importance of practical problem solving in the progress of economics Thünen was analyzing actual problems of forestry when he derived this idea. This an example of the importance of practical problem solving in the progress of economics

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Challenges for subsistence farmers Challenges for subsistence farmers Population growthPopulation growth International tradeInternational trade Drug cropsDrug crops

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Assume a central marketplace surrounded by agricultural land, all of equal fertility Assume a central marketplace surrounded by agricultural land, all of equal fertility There is one agricultural good, wheat There is one agricultural good, wheat Landowners hire workers to produce wheat Landowners hire workers to produce wheat L workers make Q(L) units of wheatL workers make Q(L) units of wheat The cost of transporting wheat to the market is t dollars per mile The cost of transporting wheat to the market is t dollars per mile The market price of wheat is P dollars per tonThe market price of wheat is P dollars per ton Therefore, wheat grown d miles away from the market will earn P – (t × d) dollars per tonTherefore, wheat grown d miles away from the market will earn P – (t × d) dollars per ton

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One good case Revenue earned = [P – (t × d)] × Q(L) Revenue earned = [P – (t × d)] × Q(L) Landowners pay each worker the wage w dollars Landowners pay each worker the wage w dollars Therefore, total wage payment = w × LTherefore, total wage payment = w × L Therefore, the landowner’s rent (or, profit) = [P – (t × d)] × Q(L) – w × L Therefore, the landowner’s rent (or, profit) = [P – (t × d)] × Q(L) – w × L The landowner chooses L to maximize this rent (or, profit) The landowner chooses L to maximize this rent (or, profit)

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One good case Adam Smith had discussed the idea of profit maximization. It was Thünen who expressed the idea as a mathematical problem, solved it using differential calculus, and derived testable hypotheses from profit maximization Adam Smith had discussed the idea of profit maximization. It was Thünen who expressed the idea as a mathematical problem, solved it using differential calculus, and derived testable hypotheses from profit maximization

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One good case Thünen defined the marginal product of labor MPL as the increase in output Q when labor L increases by one worker Thünen defined the marginal product of labor MPL as the increase in output Q when labor L increases by one worker He also assumed diminishing returns He also assumed diminishing returns That is, MPL decreases as L increasesThat is, MPL decreases as L increases He then showed that profit-maximizing landowners will choose L to make [P – (t × d)] × MPL = w He then showed that profit-maximizing landowners will choose L to make [P – (t × d)] × MPL = w This is the key idea of the marginal productivity theory of distribution This is the key idea of the marginal productivity theory of distribution

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Profit Maximization How is a firm to decide how much of a resource to use? How is a firm to decide how much of a resource to use? Profit maximization implies that the firm should follow this rule: Profit maximization implies that the firm should follow this rule: Marginal Product of a resource = Factor Price of the resource (measured in units of the produced good).Marginal Product of a resource = Factor Price of the resource (measured in units of the produced good).

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One good case When the farm’s distance to the market d is greater, P – (t × d) is smaller When the farm’s distance to the market d is greater, P – (t × d) is smaller As [P – (t × d)] × MPL = w, MPL must be higher when d is greater As [P – (t × d)] × MPL = w, MPL must be higher when d is greater Diminishing MPL then implies that L must be smaller when d is greater Diminishing MPL then implies that L must be smaller when d is greater Notice that Thünen has used the idea of profit maximization to derive a testable hypothesis: farms that are farther away from the market will have fewer workers Notice that Thünen has used the idea of profit maximization to derive a testable hypothesis: farms that are farther away from the market will have fewer workers

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One good case Moreover, farms that are farther away from the market will earn lower rent (or, profit) Moreover, farms that are farther away from the market will earn lower rent (or, profit) Why? Why? They pay more in transport cost t × d and, therefore, earn a lower price P – (t × d) for wheatThey pay more in transport cost t × d and, therefore, earn a lower price P – (t × d) for wheat

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